US Fed will have tocut rates or face deep recession

January 15, 2008

It is increasingly clear that the soft landing that central bank economists love to talk about whenever they raise rates to kill inflationary expectations is once again a chimera. The ABCP crisis continues to take its toll on the banking sector while the inexorable rise in oil prices and the waves of layoffs in housing related industries and manufacturing also are squeezing consumer spending and sentiment. This past December US retail sales fell by 0.4 % the biggest decline since the last recession.
Various financial institutions continue to report losses attributable to ABCP and sub prime mortgage crisis.Here in Canada our own CIBC bank has fired some of its money managers and reported losses of over 2 billion dollars as its bill from the debacle. In this environment it is a certainty that the Fed will lower rates perhaps by as much as 75 to 100 basis points. Given this likelihood the Bank of Canada will have to react or the Canadian dollar will once again climb above prime unless traders judge that the US recession will sufficiently damage the Canadian economy so as to warrent discounting the dollar despite the large interest rate differential.

How foolish the rate rises earlier in the year by the Bank of Canada now seem given the real as opposed to imagined state of the Canadian and American economy. Of course, at the time I was opposed to them precisely because I thought the risk was not inflation but an economic slowdown. But the powers that be at the central bank armed with an outdated and obsolete economic theory of market behaviour call the shots.

Too bad